A construction loan is a short-term financing option used to fund the building of a new home or major renovations. Unlike traditional mortgages, which are based on the home’s existing value, construction loans are based on the projected value of the property once construction is completed. These loans offer flexible terms, typically disbursed in stages as the project progresses, ensuring that funds are available when needed. Benefits of a construction loan include customized financing tailored to the specific needs of the project, interest payments only on the amount drawn, and the ability to convert to a permanent mortgage once the construction is finished. This financing approach allows homeowners or developers to manage cash flow effectively and complete projects without the financial burden of upfront costs.
Below are the 5 steps that you must follow in order to build your home using a construction loan.
1. Understand Your Terms
Loan Term: Construction loans usually have a term of 12 to 18 months.
Interest Rate: Interest rates are typically variable and slightly higher than traditional mortgage rates.
Disbursement Schedule: Funds are released in stages, known as “draws,” aligned with the project’s completion phases.
Interest Payments: Borrowers only pay interest on the funds drawn during the construction period.
Conversion: Many construction loans can be converted into permanent financing once the project is finished.
2. Fill Out Application
If you have a trusted financial institution for your construction loan, fill out their application. If you are still considering financial institutions, we suggest you look into Sanibel Captiva Community Bank, a trusted leader in construction loans in SWFL. Information and application can be found on their Residential Lending page.
3. Gather Documents Needed
It’s helpful to start gathering documentation early in the process. Though you won’t be asked for these immediately, having them ready can expedite the loan process. Typically, the documents you’ll need include:
Personal Documents
- Copy of Driver’s License
- Completed Application
- Personal Financial Statement
- Personal tax returns and schedules for the last three yearsYear-to-date (YTD)
- Profit & Loss (P&L) and Balance Sheet for any businesses owned
- Debt Schedule (showing loan details, interest rates, terms, and monthly payments)
- Personal Credit Report
Business Documents (if applying through a business)
- Articles of Incorporation/Organization
- Completed application in the business’s name
- Certification of Beneficial Ownership Form
- Business tax returns for the past three years
- YTD P&L and Balance Sheet for any business entity where you own more than 50%
- Tax ID Number for the business entity
- Debt schedule for the business (showing loan details, interest rates, terms, and monthly payments)
4. Close on the Loan
Before closing, your builder may require a deposit to cover initial costs such as prints, surveys, and permitting. Most lenders will only close once the permitting process is near completion, typically within one or two weeks of issuance.
By following these steps and understanding the process, you can secure a construction loan that meets your needs and ensures a smooth path to building your dream home.
5. Stick to the Draw Schedule
In a construction loan, it’s essential that the contractor adheres to a pre-established draw schedule, which outlines when and how funds will be released throughout the project. The lender will only disburse additional funds once the work from the previous draw has been independently verified as satisfactorily completed. This ensures that the project stays on track and that the lender maintains oversight of the progress. Regular inspections by the lender or a third party are typically required to confirm that each phase of construction has met the agreed-upon standards before releasing the next portion of funds. Sticking to this schedule is crucial for keeping the project financed and moving forward smoothly.